Income & Investing

The 10-year U.S. Treasury note currently yields 1.75%. By comparison, the top ten average dividend yields of the Dow Jones Industrials are 3.9%. The average yield of dividend payers in the S&P 500 is 2.7%. This yield difference between stocks and bonds is unusual. Equity yields relative to bonds have not been this wide since 1956. While this condition hardly assures an imminent bull market, the mid-1950s was indeed one of the best times in history to have bought stocks.

Dividends have an advantage over bonds. Bond coupons are always the same over the entire holding period until the bond’s maturity date. Dividends, however, generally increase over time right along with the growth of corporate profits. Even though dividend cuts and eliminations can occur, such events are a relatively small percentage of all cash payouts. Such risk can largely be reduced through diversification.

Yield-hungry investors often seem most attracted to stocks with the highest absolute yield. However, companies with increasing dividends tend to be the best stocks to own over time. In the past decade, for example, companies in the S&P 1500 with the highest dividend growth rose 159% compared to just 36% for those with high absolute yield but low dividend growth. The difference is especially striking in global markets where the highest dividend growers gained 232% as the high yield, low growth payers rose only 60%.

Still, bonds look like a good choice today largely because bond investors have done so well for so long. A decade ago, however, technology stocks also looked like a good place to put money because technology had also done well for quite a while. Popularity, however, should never be an investment strategy. In fact, trendy assets should be viewed with skepticism. Still, investors seem to only reconsider their notion of a sound investment long after the losses have begun to pile up.